Price Discrimination and Inventory Allocation in Bertrand Competition.

This article analyzes the interplay between price discrimination and inventory allocation in Bertrand competition involving two firms with differentiated product quality and heterogeneous customer segments—price-sensitive customers (PSCs) and quality-sensitive customers (QSCs). It establishes that customer heterogeneity acts as a market friction that allows firms to avoid the classic Bertrand price race to the bottom, benefiting the higher-quality firm with more quality-sensitive customers and the lower-quality firm with a more heterogeneous customer base. The study finds that price discrimination alone can intensify competition and reduce profits by eliminating this friction, but when combined with strategic (endogenous) inventory allocation that creates capacity constraints within segments, firms can restore market frictions and increase profits. Real-world examples motivating the model include regional pricing in fast fashion and vaccines, where firms commit inventory by segment. The results show that under low demand, price discrimination with strategic inventory allocation outperforms uniform pricing, whereas under high demand, uniform pricing can sometimes yield higher profits depending on market composition, highlighting the critical role of inventory management in designing competitive pricing strategies.